Last week I received a call from a client who wished to include a “donate to eliminate” clause in his will. His goal is to wipe-out all taxes in his estate by giving just the right amount to his favorite charities.
A few years ago, this planning idea was all the rage in gift planning circles. It turned on a model clause that directed the executor to calculate the value of a donation to fully offset taxes owing in the final lifetime return. Wills with this clause should now be reviewed due to changes in the underlying tax rules.
First some context. Canadian taxpayers may make a gift by will and conceivably offset most of the taxes owing. This is due to the 100% contribution limit in the final two lifetime returns. In 2016, the tax benefits of estate donations increased further, expanding the donation claim period for up to five annual estate returns to the limit of 75% of net income. These are the so called “estate donation” rules.
When the “donate to eliminate” clause was first proposed, the taxation of gifts by will was easier to calculate. With the pre-2016 rules, per 118.1(5), a “gift by will” notionally occurred just before death, which coincided with the deemed disposition of capital and other taxable property. In the year of death the executor could calculate the tax owing and the resulting donation amount.
With the post-2016 estate donation rules, the calculation is tougher. Now the donation occurs when the property is delivered to the charity during the estate administration process and there are may be multiple distributions. Each payment produces more tax savings for the estate and may generates additional tax filings. This is the so-called “estate donation loop“. Rather than a single tax bill to eliminate, the total tax savings are claimed in a number of estate returns. The tax credits are more difficult to calculate, which increases the liability for the executor.
Value of the Donation
The other concern about tying the value of the donation to the tax liability is that no amount or percentage is named in the will. The donation amount can grow, or shrink, based on the underlying tax liability of the estate. This variability may produce doubt about whether the donor understood the value of the ultimate gift. Family beneficiaries may well ask, “did Dad really mean to be so generous?” Doubt incubates litigation.
Tax Credit Rates
The final change to the planning environment is the donation tax credit rates. When the “donate to eliminate” clause was initially floated the highest tax credit rate and the top marginal rate were the same in most provinces. The credit would offset the liability. Since the 2016 federal tax hike, tax credits rate have decoupled from top marginal rates, leaving two or three percentage points of tax that can’t be eliminated at death. The promise of the eliminator clause is undermined.
So donor beware. The promise of eliminating tax with a simple will clause is more complex and less satisfying than it seems. Tax benefits vary depending on the situation and charitable intent should be part of the calculation.